Chairman's Statement
Dear Fellow Shareholders,
This past year has certainly played out differently than expected and has ushered in a very challenging period.
Significant Events
The most significant event in 2008 was, clearly, the advent of the global crises that initially plagued the financial markets and rapidly spread to the mainstream of the worldwide economies.
The first half of the year saw significant growth in our revenues - nearly 18%. The Group indeed reported a record figure of US$ 21.9 million for the first six months' revenues, while retaining our historic gross margin levels - 65.6%. The growth was mostly attributed to the then-ongoing demand for our traditional products, as well as improved sales of the Quazer green laser system, which contributed over 10% of total revenues in H1 2008, in our key market in India and continued market expansion in the emerging market in Africa - 359% growth year over year. Similar growth was realised in our profits - just over 17% before adjusting for a loss in our then newlyacquired minority interest in IDEX Online SA ("IDEX Online").
A special moment of pride occurred in September when Indian diamond manufacturer and exporter Kiran Gems, one of the world's largest rough diamond processing groups, with over 20,000 employees worldwide, became Sarin`s first customer to reach 200 Sarin DiaMarkTM rough diamond planning system installations at its manufacturing facilities in India. Kiran Gems and the other Sarin Century Club (the exclusive list of Sarin clients using at least 100 of Sarin's rough planning systems) members' repeated purchases are a clear vote of confidence for Sarin's leadership status as a vendor to the global diamond manufacturing industry.
However, commencing in September, and accelerating dramatically during the last quarter of the year, market conditions deteriorated as the global recession made its mark felt in all our target markets. Indeed, in our key Indian market, the diamond manufacturing industry extended its normal 2-3 week Diwali break to a full 6 weeks from late October through early December, and even after Diwali did not resume anything near full production activity. Affected by a surplus in polished diamonds, as the global demand rapidly dissipated, and by production over-capacity, as well as by a credit crunch from shaken financial institutions, the manufacturers opted for extended shutdowns, partial re-openings accompanied by staff layoffs and, in some instances, closures.
Due to the now-expected, continued slowdown in our markets, the Group has continued its efforts to reduce its operating expenses. In addition to the 20% reduction implemented in Q4 FY2008 (only a portion of which were reflected in the reported operating expenses of that quarter), ongoing efforts are expected to further decrease our operating expenses by approximately 15%. The expected savings stem from further staff reductions already executed, pay cuts, a decrease in sales commissions being paid, and a reduction in other operating expenses. To highlight a few of our recent management staff changes, most of them a direct result of our expense reduction plan: our VP R&D and CTO positions have been unified into the CTO position, to be continued by Abraham Meir Kerner; our Manufacturing Market and Retail Market business activities, previously managed by two separate Vice Presidents of the Group, have been unified into a single position, to be continued by Akiva Caspi, who will also be responsible for Marketing, after eliminating our VP Marketing position, in lack of sufficient activities to justify full-time staffing of this position; our polishing discs activity, previously managed by a dedicated Vice President of the Group, is now under the responsibility of the General Manager of Sarin India, for reasons of cost reductions both in management and staff of this business activity, as well as being closer to the target market in India; a final management change to take place in Q2 Y2009 is the appointment of Zafrir Engelhard as the General Manager of Sarin India, replacing and reporting to David Block who will be appointed VP Worldwide Sales.
Overall, we expect 2009 to be a challenging year as the global economy struggles with significantly less sales than in 2008. Cash flow and profitability are our main concerns. Our strategy for the year revolves around the roll out of the new Galatea technology, which we believe will be a compelling offering, especially in these trying market conditions.
Indeed, the second most significant event of 2008 was the acquisition of Galatea Ltd. ("Galatea"). Acquired in Q2 FY2008, Galatea possesses unique, patent pending, technology for the detection and mapping of internal features in rough and polished diamonds. The advantage of Galatea's technology over any other competing technology currently applied to the same objectives, is that it is automated and is thus much quicker, more comprehensive, more accurate, and requires less skilled staff for its operation.
Over the past twelve months, Sarin's research and development team, along with Galatea's highly skilled technical personnel, have brought the technology to product stage. Integration with Sarin's existing rough planning products has been completed. Beta testing in Israel and India has been ongoing for some time. And, as a result of customer requests, we have begun offering, albeit on a limited basis intended for further in-depth evaluation purposes, an inclusion detection and mapping service at two fee-charging service centres in India and Israel. We have thus begun to realise what we believe, over time, may become a significant source of recurring service-based income.
We expect to further roll out this Galatea service offering during Q2 and Q3 FY2009, expanding capacity in India and establishing a service outlet in Belgium, most likely followed by Russia, China and/or South Africa. Commercial offering of the product to customers for use on an in-house basis, against initial payment for the hardware and an ongoing software license fee based on actual utilisation is expected, as planned, late in Q2 FY2009.
The third important event in 2008, whose fruits we have yet to reap, is the acceptance of our laser marking system patents in India, after long years of anticipation. The significance of these patents is that they potentially award Sarin an exclusive right to manufacture, market, and sell our laser marking systems in India, and prohibit our competitors from profiting by providing their customers with similar products. Subsequently to having been granted these patents, we have initiated litigation against those of our competitors whom we believe have infringed these important patents.
Group Performance - Year in Review
For the year ended December 31, 2008 the Group recorded a decline of 10.7% in revenues in comparison to the twelve months ended December 31, 2007, from US$ 37.1 million to US$ 33.1 million. The decline is mostly attributed to the dramatic drop in demand for all our products in the last three months of the year, as a result of the global financial and economic crises and their impact on the diamond industry, as elaborated on above.
On the expense side, during the beginning of FY2008 a larger research and development team was recruited, as we continued to invest in upgraded and new products, resulting in higher research and development costs. Higher sales and marketing expenses were also incurred to support our growth in India and Africa during the initial part of the year, as well as to support our activities in other markets. Our general and administrative expenses increased for a number of reasons, many of which were one off issues, having to do with our restructuring, as detailed below, and the legal arbitration with Credit Suisse, which ended favourably for the Company.
As a result of the negative developments in the last quarter of the year, the Group has undertaken significant reductions in its operating expenses in all areas, both by reducing staff as well as by cutting other expenses. Operating expenses were reduced in Q4 FY2008 in comparison to Q3 FY2008 by approximately 24% and during Q1 FY2009 the Group continued to take additional measures to further reduce fixed operating expenses by an additional 15%.
The weakening of the US$ compared to the New Israeli Shekel (NIS) increased our overall expenses for the year ended December 31, 2008, primarily due to salary and related costs for employees in Israel, incurred in NIS but reported in US$. Commencing in Q3 FY2008, and more significantly in Q4 FY008, we witnessed a reversal of the trend experienced during H1 2008, and the US$ regained value against the NIS. This trend helped to reduce our manpower costs in Israel in Q4 FY2008.
Overall, the Group's profit before tax for the year ended December 31, 2008 decreased 47.9% from US$ 10.5 million to US$5.5 million.
As a result of the operating loss incurred in Q4 FY2008, and the challenging period facing the Group, as the diamond industry goes through some very difficult times, Sarin took a one-time write off of tax assets of approximately US$ 1.2 million in Q4 FY2008.
Thus the Group's profit after tax for the twelve months ended December 31, 2008 decreased by 52.7% from US$ 8.0 million to US$3.8 million, compared to the twelve months ended December 31, 2007.
During FY2008 Sarin invested in two companies - Galatea and IDEX Online. As described above, progress on the commercialisation of the Galatea technology is in line with the previously reported plans and expectations. The execution of IDEX Online's commercialisation plans of its unique Guaranteed Diamond Transactions online trading platform has been significantly less successful than expected, mainly due to the crisis in the diamond industry and is expected to continue to face challenging market conditions for some time. As a result of this, along with a significant drop in advertising revenues also related to the diamond industry downturn, and the resulting losses incurred in its ongoing activities, Sarin has adjusted downward its investment in IDEX Online by approximately US$ 1.8 million.
Due to the adjustment, the Group's profit for the year ended December 31, 2008 after our share in IDEX Online losses and the adjustment of our investment, decreased by 80.1% from US$ 8.0 million to US$ 1.6 million.
Dividend
The Board of Directors has recommended that no additional final dividend be distributed for FY2008, in addition to the interim dividend paid mid-year.
Looking Ahead to 2009
We expect the following industry trends to continue to influence our business well into 2009:
a. The global economic slowdown which has dramatically slowed the diamond industry is expected to continue to hold sway over much, if not all, of 2009. Industry consultants cite the recession's impact on the global demand for luxury goods in general, and on the vital US market, which still consumes over 40% of the polished diamonds produced, in particular, and forecast that the drop in demand for rough diamonds and their processing may reach 50% to 60%. However, looking forward to 2010, it is to be noted that demand is still growing in India and China, and some market participants expect these two markets to equal the US market by the end of this decade.
b. One of the most crucial issues facing the diamond industry is how much business activity the banks will continue to finance. Indeed, the credit freeze which followed the financial crisis has created difficulties for both consumers and businesses in the diamond industry itself. This has contributed to the slowdown in the industry in general, and has led to a dramatic slowing of capital equipment expenditures in particular.
- A number of negative factors continue to afflict our
main customers, diamond manufacturers in India and
elsewhere:
- An existing inventory of polished diamonds, which is
hard to sell off and which has been impacted by
recent price reductions in polished goods - these
have fallen by 13% to 16% (depending on industry
source) in the past 6 months (August 2008 to January
2009);
- Surplus production capacity, which has led to
prolonged shutdowns, layoffs and even plant closures;
- Credit freeze.
d. The global economic slowdown has, however, produced a secondary positive side-effect for the industry - recent reductions in the prices of rough diamonds by most producers have somewhat eased the cost to manufacturers, and may thus induce more activity, which could hasten the recovery from the current slump.
e. The Russian diamond industry is on hold, as a result of repeated delays and changes in policies enacted by the Russian government, related to taxation as well as to the percentage of diamonds produced in Russia which needs to be manufactured domestically. Once resolved, these issues may result in an increase in the manufacturing activities in Russia and create new opportunities for our product sales.
f. In the southern African region the effects of the global slowdown are also being felt.
The Group continues to focus its Research and Development initiatives on projects that may contribute to revenues in the challenging twelve-month period ahead.
The Galatea product: Sarin is currently on track to offer the benefits of the Galatea technology, initially as a new service through service centres, which will provide the automated, comprehensive and accurate mapping of inclusions within a rough diamond in a far shorter time compared to using other currently available techniques. Sarin has begun offering this service, on a limited trial basis, to its diamond manufacturing customers in Israel and in India as of Q1 FY2009. Sarin intends to gradually ramp up its service capacity in India in Q2 FY2009, and to thereafter introduce the service to other diamond manufacturing centres. The commercial launch of product sales, on a limited basis, so as to best control the product's introduction to the market, is planned for late in Q2 FY2009.
Rough planning products: This line of products has historically been the Group's primary contributor to revenue, and our share in the market continues to remain dominant. We anticipate that when the market returns to more robust activity sales of automated planning solutions, especially those enhanced by the new Galatea technology, may pick up. R&D efforts currently focus on integrating these products with the Galatea technology, where applicable, and utilising its added value to a greater extent to optimise the planning process. We anticipate that this will significantly widen the positive gap between our products and the products of our competitors, primarily in regards to rough diamond yield optimisation.
Polished planning products: The Company has also continued with the development of its Instructor product, for the ongoing quality control of the polished diamond during the manufacturing process and for the instruction on necessary corrective actions on flawed polished diamonds. This product is currently in alpha testing and preliminary demonstrations to customers for functionality feedback.
Quazer: We believe that the Quazer has emerged as the most advanced and most reliable green laser sawing and shaping system in the market. It has been demonstrated to offer customers the highest productivity and lowest breakage rates available. R&D efforts are focused on improving the system's breakage rate even further. As a result of customer interest, the adaptation of the Quazer to synthetic CVD (Chemical Vapour Deposition) diamond manufacturing needs has also been initiated. This may open a new market for the Quazer for the cutting and shaping of these synthetic CVD diamonds for industrial applications outside the diamond jewellery industry. An initial pair of systems has been delivered for evaluation purposes to two European customers.
Polishing discs: Initial feedback from Indian customers utilising the disc for manual, as well as automated, polishing has been generally positive. Though we believe that the disc has competitive advantages in the early stages of polishing (termed "blocking"), having been delayed by the extended Diwali holiday closures, we are still continuing our tests and have yet to fully ascertain whether this product is economically viable.
Colour products: The latest version of the Colibri is showing satisfactory results and therefore only minimal further R&D is being carried out, aimed at further refinements.
IDEX Online: The global economic slowdown has definitely impeded the adoption of IDEX's unique online spot market trading platform and has also had significant impact on the company's traditional sources of income - subscription fees and advertising revenues. IDEX is exploring new outlets for its services and hopes to expand its presence both in the traditional, as well as online diamond trade. This is crucial to IDEX's prospects for FY2009.
In what will clearly be a challenging environment in FY2009, we will focus on the Galatea technology rollout, as well as on retaining or expanding, where possible, our market share in all key markets.
Acknowledgements
Together with my fellow directors, I would like to thank our customers, shareholders, suppliers, business partners and most of all our management and employees for their ongoing support and dedication to the Group. We believe that these valued relationships will provide the means by which we will weather the current times, while we yet again revolutionise the diamond trade and manufacturing industry with the Galateaenabled inclusion and Clarity mapping.
Finally, I would like to finish with a word of thanks to Zeev Leshem, our former CEO who left our Group's employ last year after sixteen years of service. On behalf of the entire Board of Directors, we thank Zeev for all his long years of dedicated service and wish him well in his future pursuits.
Daniel Benjamin Glinert
Executive Chairman
